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Thursday, December 19, 2013

Monetary reunification — complex, gradual and slow

The following is the translation of an essay written by José Luis Rodríguez, a Soviet-trained economist, former minister of finance and one of the architects of Cuba’s dual monetary system in the 1990s, as well as a former minister of economy. Rodríguez is now an advisor to the Centro de Investigaciones de la Economía Mundial (CIEM) in Havana. The analysis first appeared in Cuba Contemporánea in November.

By José Luis Rodríguez

The introduction of the dual currency system in the 1990s created a segmentation of domestic markets. One of them operated in Cuban pesos (CUP), both on the enterprise level and between individuals, while the other first operated in US dollars and, beginning in 2004, in convertible Cuban pesos (CUC).

The segment that worked with hard currency had a different monetary policy; for operations between legal persons, a 1:1 exchange rate was maintained between the CUP and the dollar or CUC. Meanwhile, for natural persons the exchange rate was handled by CADECA, according to the domestic market, through a rate that began at 35 CUP in 1995 and that currently is at 25 CUP per CUP.

The cost of these decisions in the relations between legal persons — discounting the positive effects of the dual currency system in the short run — manifested itself in the difficulty of measuring economic facts in two currencies that were linked to each other in an exchange rate that overvalued the Cuban peso vis-a-vis the dollar. In that sense, when the two currencies were inserted into the accounting of enterprises, their true situation was distorted, leading to a high level of imported components that appeared to make fiscal sense, as the external cost was accounted for in CUP. Inversely, exportable production appeared to be unprofitable, as the external income was minimized when accounted for in that currency.

Eventually, the official exchange rate tended to stimulate imports and discourage exports, worsening the trade deficit.

For the people, on the other hand, the CADECA exchange rate reflected a very devalued CUP vis-a-vis the dollar or CUC, as it was regulated by offer and demand in the domestic market. An excess in monetary liquidity of the CUP put upward pressure on the exchange rate, making hard currency more expensive.

This situation has continued until today, if we take into account that liquidity in the hands of people in 2012 represented about 42 percent of GDP, reflecting latent inflationary pressure.

In the current circumstances, the monetary reunification process requires an adjustment of the two exchange rates. On one hand, it will be necessary to first devalue the official exchange rate for legal persons, to achieve its convergence with the CADECA exchange rate. Due to that, the adjustment will possibly take three years or more.

The speed and the way in which the devaluation of the official exchange rate is done are of great importance. In a Socialist society, a sudden devaluation — with the negative side effects typical for neoliberal policies — is not possible.

The gradual approach announced in the currency reunification must guarantee the highest possible economic stability and security for all members of society. Therefore, we should expect the step-by-step introduction of different exchange rates by sector. This, in turn, will bring about a complex process of creation of financial reserves, accompanied by transformations of the legal, accounting and statistical framework.

Already, since 2011, exchange rates of 10 CUP per CUC have been tried in sales of agricultural products to the tourism sector. In the sugar industry a system of multiple exchange rates is being used; the enterprises included in the experiment are working with a 10:1 exchange rate.

The impact of this course of action, logically, will be different according to the economic activity in question. Once the CUP is devalued, enterprises that show negative results should be undergoing an analysis to determine whether the state should assume a short-term compensation through its fiscal and credit policy, with the aim of giving them time to adapt to the new circumstances.

Exporting entities, and those able to substitute imports, should achieve a relative improvement in their competitiveness in the short run.

In any case, the elimination of the dual monetary system for judicial persons will have a certain short-term cost and benefit that will manifest itself in the mid-term.

As far as people are concerned, the expectations of natural persons for the elimination of the dual system tend to be higher than what should be expected to really happen. The majority of citizens associate the dual system with unequal distribution of income and rising cost of living; many expect that its suppression will eliminate those negative effects.

It’s correct that, when remittances by a part of the population (that does not exceed 25 percent of the total) were approved in 1993, inequality in the distribution of income inequality rose. Likewise, when a high tax on the sale of goods and services in hard currency was introduced as part of the state policy to socially redistribute part of that income in a population segment, prices turned out to be very high for the median income of the country.

Nevertheless, these harmful side effects were inevitable in the face of the urgent need of hard currency for the survival of the nation in the worst years of the Special Period. This was a painful decision, but the Cuban government had no alternatives. The dual system was conceived as a transitional policy to eventually be overcome, as the economy recovered.

However, due to existing economic malformation, the crisis of the Special Period, as well as increased pressure of the U.S. blockade, together with an international economic crisis that became recurrent in the next decade, and the errors in the economic policy of the country, the dual system was extended during 20 years.

Today, it’s possible to begin to revert the situation.

In the current circumstances, and based on the profound transformation of economic policy that is being carried out — and only using it as a premise — it’s feasible to undertake a gradual process that allows aligning the true value of the Cuban peso with the level of development reached by the country, making it comparable with the international economy. This process should count on a program that allows confronting the different obstacles that will present themselves along the way, to reach the best possible results.

In summary, the decision adopted to begin on the path that allows a correction of the deformations that resulted from the dual monetary system is indispensable to advance towards the updating of the Cuban economic model. This correction will allow to measure with higher precision the economic facts and will create the conditions to reorder the Cuban economy — including prices and salaries — by emitting the right signals for decision-making.

A correct understanding of this process is necessary, because monetary reunification by itself is possibly the most complex process in the update of the Cuban economic model, and it requires a high level of organization, foresight and flexibility to reach its objectives.

We must not lose sight of the fact that monetary unification will only create the conditions to improve economic management and its measurement, but overcoming the problems that today affect the production of goods and services and people’s income will only be possible with a profound structural change in the economy, which will move through a stage of higher investment of resources and an increase of work productivity, the only alternatives available to make use of more wealth.